This will compel banks to conserve capital and moderate their balance sheets during periods of fast credit growth, feels the rating agency
GN Bureau | February 12, 2015
Last week’s guidelines on maintaining a countercyclical capital buffer (CCCB) by Reserve Bank of India has been hailed by the global credit rating agency Moody's .
The guidelines are credit positive for Indian banks because they make clear that banks will be required to hold the additional capital amid periods of rapid credit growth, according to an article in Moody's Credit Outlook.
The guidelines maintaining CCCB is not expected to get activated in 2015 but "nevertheless, these guidelines provide the RBI with a tool to compel banks to conserve capital and moderate their balance sheets during periods of fast credit growth, which would benefit the banks' credit quality," the Moody's said.
According to Moody's, India's domestic credit/gross domestic product (GDP) ratio has consistently increased over the years.
The level at the end of March 2014 stands at 80.2 percent, which remains within the three percentage point acceptable range of the five year average of 78.2 percent, according to an article in Moody's Credit Outlook.
The guidelines on CCCB act as an additional layer of loss-absorbing capital on top of the banks' increased minimum capital requirements under Basel III.
Basel III gives regulators in individual jurisdictions the discretion to implement a CCCB of up to 2.5 percent of risk weighted assets when they see fit, to offset pro-cyclicality by requiring banks to hold more capital at times when the regulator judges that the macro-financial environment could encourage excessive risk-taking.
According to Moody's, corporate loans, which account for about 80 percent of Indian banks' loan exposure, have negatively affected banks' asset quality owing to high corporate leverage, and the asset quality of loans to households have been relatively stable.
Thus, the RBI has focused its triggers on overall domestic credit and the health of banks and corporates to sustain the increase in credit.
According to the RBI's guidelines, the key trigger for activating the CCCB will be when the credit/GDP ratio has risen relative to its long-term trend.
The RBI said it will require banks to hold the full 2.5 percent buffer when the gap between the credit/GDP ratio and the long-term trend exceeds 15 percentage points.
The central bank will implement a CCCB of less than 2.5 percent when the gap is between three and 15 percentage points, with the size of the required CCCB increasing on a graduated scale.
Although the credit/GDP ratio will be the key trigger, the RBI said it will maintain its discretion when reducing the CCCB, and will also look at other indicators, including banks' ratios of loan to deposits, non-performing assets and interest coverage.
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